Katrina's Economic Ripples

September 27, 2005

By Michael Englund and Rick MacDonald The markets have been awaiting data reports released in the aftermath of Hurricane Katrina to get a read on the storm's impact on key sectors of the U.S. economy. On Sept. 27, Wall Street got a glimpse, thanks to a key release on consumer sentiment -- and the results weren't pretty.

The Conference Board's consumer confidence data for September certainly didn't disappoint those looking for a big post-Katrina effect. The index plummeted to 86.6 for the month -- the lowest level since October, 2003, and well below economists' median forecast of 95.0 -- from 105.6. in the prior month. Katrina exacted a heavy toll on sentiment both from negative news stories and the related surge in gasoline prices. In addition, there was a high likelihood of a downside correction in this figure, given its outperformance relative to other sentiment surveys in the June-August period.

HUGE DROP.The decline in the headline index was led by the expectations component, a gauge of consumers' view of economic conditions in the coming months, which fell to 71.7 from 93.3. The present situation component held up better, moderating to only 108.9 from 123.8.

The concentrated weakness in expectations was the type of temporary swing typically related to events like hurricanes. But the present situations index revealed remarkable restraint, given the pressures from soaring energy costs and fears of the unfolding impact of the two big late-summer hurricanes. While it stood at its lowest level of 2005, "present situations" remains well above all 12 readings from 2004 -- when consumption posted solid growth.

Despite the huge drop in confidence to levels that are normally more associated with recession, we at Action Economics don't expect the decline in sentiment to have much impact on spending. Higher energy prices will sap some strength from real growth, but sentiment is likely to rebound handily once disruptions from Katrina and her sibling, Rita, abate. We would also note that readings for the present conditions index remain firm.

NOTABLY WEAKER. As Katrina occurred late in the month, it did not likely have a significant impact on another key report for August released on Sept. 27. New-home sales plunged 9.9% in August, to a 1.237 million unit annual pace -- below economists' median projection of 1.335 million. Prior months were all revised lower. Along with the weak August data, that left a notably weaker trajectory for new-home sales.

All four regions declined, led by a 22% drop in the Northeast and an 18% decline in the West. The Midwest declined 11%, while the South was off only 2%. Inventories rose 2.6% to a record 479,000 units. The weakness in sales and further gain in inventories left the supply of new homes at 4.7 months, compared with 4.1 months in July. This represents the highest level of supply since June, 2000.

TWIN TEMPESTS. But strength in prices in August, and upward revisions in the prior three months, partly closed some of the wide gap between growth in new- and existing-home prices over this past year. On a year-over-year basis, new-home prices are now up 1%. After ratcheting up average prices sharply in 2004, new-home builders have targeted production of homes at the same price point this year, leaving little year-over-year appreciation. The 15.8% year-over-year surge in existing home prices in August, reported on Sept. 26, has left nearly the same median price by both measures -- around $220,000.

Ultimately, we expect that the weakness evident in August's new-home sales will prove temporary. And ironically, the spur will be the Gulf's twin tempests. We expect new-home sales will get a boost in the months ahead from hurricane rebuilding efforts -- a silver lining amid the economic gloom caused by Katrina and Rita.

Englund is chief economist, and MacDonald global director of investment research and analysis, for Action Economics